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Summary

Given its relatively low savings rate, the U.S. economy depends heavily on foreign capital inflows from countries with high savings rates (such as China) to help promote growth and to fund the federal budget deficit. China has intervened heavily in currency markets to limit the appreciation of its currency, especially against the dollar. As a result, China has become the worlds largest and fastest growing holder of foreign exchange reserves (FER). China has invested a large share of its FER in U.S. securities, which, as of June 2008, totaled $1.2 trillion, making China the second largest foreign holder of U.S. securities (after Japan). These securities include long-term (LT) Treasury debt, LT U.S. agency debt, LT U.S. corporate debt, LT U.S. equities, and short-term debt. It is likely that China became the largest foreign holder of U.S. securities by the end of 2008. From June 2002 to June 2008, China's holdings of U.S. securities increased by over $1 trillion--far more than that of any other nation. U.S. Treasury securities are issued to finance the federal budget deficit. Of the public debt that is privately held, a little more than half is held by foreigners. As of May 2009, China's Treasury securities holdings were $802 billion, accounting for 24.3% of total foreign ownership of U.S. Treasury securities, making it the largest foreign holder of U.S. Treasuries (it replaced Japan as the largest foreign holder in September 2008). The current global financial crisis has raised considerable concern in the United States over the willingness of foreigners, including China, to continue to invest in U.S. securities, particularly Treasury securities, which will be used to help finance U.S. spending programs intended to promote economic recovery. During her first visit to China in February 2009, Secretary of State Clinton urged China to continue to buy U.S. Treasury Securities. In March 2009, Chinese Premier Wen Jiabao stated that he was a little worried about the safety of China's asset holdings in the United States. In addition, some Chinese government officials have called for replacing the dollar as the worlds main foreign reserve currency. Given the sharp decline in China's net exports and foreign direct investment flows into China (major sources of Chinas foreign exchange reserves), it is not clear how much new U.S. debt China will purchase in the months ahead. Data from the Department of Treasury indicate that in recent months China has sought to reduce its holdings of LT U.S. agency debt, while increasing its holdings of short-term U.S. Treasury securities deemed by China to be more safe and secure. Some analysts contend that China might decide to unload a large share of its U.S. securities holdings, which could induce other foreign investors to sell off their U.S. holdings as well. Such a move could lead to a sharp depreciation of the dollar in international markets and force the United States to raise interest rates, which could significantly dampen U.S. economic growth, all else equal. Other observes counter that it would not be in China's economic interest to suddenly sell off its U.S. investment holdings. Doing so could lead to financial losses for the Chinese government, and any shocks to the U.S. economy caused by this action could ultimately hurt China's economy as well. The issue of China's large holdings of U.S. securities is part of a larger debate among economists over how long the high U.S. reliance on foreign investment can be sustained, to what extent that reliance poses risks to the economy, and how to evaluate the costs associated with borrowing versus the benefits that would accrue to the economy from that practice.

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